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What is Economic Value Added (EVA) and Market Value Added (MVA) ?


Economic Value Added (EVA): It measures the economic profit of a company. It helps to determine the excess money earned after deducting the capital invested in a company. If economic value added is positive it shows increase in shareholders wealth and vice versa.

Formula:
EVA = Net operating income after tax – (weighted average cost of capital * total capital employed)
Weighted average cost of capital = Cost of equity + Cost of debt after tax

Market Value Added (MVA): It measures the external value or market value of a company. If MVA is positive more investors are attracted to invest in a company. If market value added is negative the existing investors earns less return and company losses interest of a investors towards company stocks.

Formula:
MVA = V – K
OR
MVA = (Outstanding shares*price per share + outstanding preferred share*price per preferred share) – book value

Where,
V = market value of a company
K = capital invested

Advantages of Economic Value Added:
·         It helps to determine the department or area which is not working properly.
·         It helps to measure the goodwill of a company.
·         It acts as a tool which helps in taking a decision.
·         It also measures the efficiency of a manager that how efficiently they utilise the existing assets besides buying a new one.

Disadvantages of Economic Value Added:
·         It does not forecast future cash flows.
·         It is calculated on the basis of current earnings of a company.
·         It is difficult to calculate.

Advantages of Market Value Added:
·         It acts as a tool which measures the market value of a company.
·         It is useful when the stocks of a company traded in stock exchange.
·         It shows the company is able or not to survive in the competitive market.

Disadvantages of MVA:
·         It is not useful when the stocks of a company traded in over the counter.

Example: Find out the economic value added with the help of following information:

Particulars
Amount (in Rs.)
Operating income
5, 00,000
Weighted average cost of capital
6.6%
Capital invested
3, 40,000
Tax
30%

Solution:
Net profit after tax = 5, 00,000 – 1, 50,000 = Rs. 3, 50,000
Economic Value Added = Net operating income after tax – (weighted average cost of capital * total capital employed)
= 3, 50,000 – (3, 40,000*0.066)
= 3, 50,000 – 22, 440
= 3, 27,560
The positive EVA shows the company is able to cover its cost of financing the project and the project increase the shareholders wealth.

Example: Suppose Company invested Rs. 8, 70,000 in a project. The current year sales are Rs. 10, 00,000 and cost of goods sold is Rs. 2, 60,000. The administrative expenses and selling & distribution expenses related to sales are Rs. 1, 80, 000 and Rs. 3, 10,000 respectively. The interest received of  Rs. 10, 000. The weighted average cost of capital is 7.2%. Company paid 30% tax on income. Find out the EVA.

Solution:
Particulars
Amount
Sales
10, 00,000
Less: Cost of goods sold
2, 60,000
Gross profit
7, 40,000
Less: Operating expenses

Administrative expenses
1, 80,000
Selling & distribution expenses
3, 10,000
Operating income
2, 50,000
Less: non- operating income
10,000
Net operating income
2, 40,000
Less: tax
72,000
Net operating income after tax
1, 68,000

EVA = Net operating income after tax – (weighted average cost of capital * total capital employed)
= 1, 68,000 – (0.072 * 8, 70,000)
= 1, 68,000 – 62, 640
=Rs.  1, 05,360

Example: Find out the Market Value Added with the help of following information:

Particulars
Amount (in Rs.)
Market value
6, 60,000
Capital invested
6, 00,000

Solution:
MVA = V – K
= 6, 60,000 – 6, 00,000
= Rs. 60,000
The positive MVA increases the goodwill of a company and attracts more investors.

Example: Find out the MVA from the given information:

Particulars
Amount
Outstanding shares
50, 000
Price per share
10
Book value
Rs. 6, 00,000

Solution:
MVA = (Outstanding shares*price per share + outstanding preferred share*price per preferred share) – book value
= (50, 000*10) - 6, 00,000
= 5, 00,000 – 6, 00,000
=Rs. - 1, 00,000


Comments

  1. Sarah KhanMay 10, 2021 6:33 pm

    thanks for this. It really helped me :)

    ReplyDelete
    Replies
    1. Jyoti YadavMay 12, 2021 3:05 pm

      Happy to help you Sarah Khan and thanks for your comment.

      Delete

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